The State Of REITs: August 2019 Edition

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Includes: AHT, AINC, BBRE, BHR, CDOR, CDR, CXW, EWRE, FREL, FRI, GEO, ICF, IIPR, INDS, IYR, KBWY, MAC, NETL, NURE, PEI, PPTY, PSR, REZ, ROOF, RVEN, RWR, SCHH, SRET, SRVR, USRT, VNQ, VRAI, XLRE
by: Simon Bowler
Summary

The average REIT has had a positive total return in 6 of the first 7 months of 2019, including a return of +1.76% in July.

Micro cap REITs had a very strong July, outperforming large caps by 338 basis points.

Nearly 70% of REITs securities had positive total returns in July.

Single Family Housing and Shopping Centers were the top performing REIT property types in July, while Corrections and Timber struggled.

24 out of 25 large cap REITs trade at a Price/FFO premium to the average small cap REIT.

REIT Performance

The REIT sector continued its strong 2019 performance in July (+1.76%), bringing the average equity REIT to a stellar return of 20.80% over the first seven months of 2019. REITs saw gains largely in line with that of the broader market in July, falling short of the NASDAQ (+2.11%), but outpacing the S&P 500 (+1.31%) and Dow Jones Industrial Average (+0.99%). The market cap weighted Vanguard Real Estate ETF (VNQ) achieved a slightly weaker return than the average REIT in July (+1.70% vs. +1.76%), but maintains a small lead after the first 7 months of the year (+21.19% vs. +20.80%). The spread between the FFO multiples of large cap REITs (21x) and small cap REITs (12.9x) remained wide in July as multiples rose for REITs of all sizes. Will large cap REITs continue to command multiples 8+ turns above peers? Is this huge large cap premium warranted or has REIT pricing become distorted by heavy investment into market cap weighted REIT ETFs. In this monthly publication, I will provide REIT data on numerous metrics to help readers identify which property types and individual securities currently offer the best opportunities to achieve their investment goals.

Source: Graph by Simon Bowler of 2nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

Micro cap REITs (+5.28%) had a particularly strong July, while their larger peers all had gains of less than 2%. Micro-cap REITs remain the top performers year to date as well (+30.90%), outpacing the average REIT (20.80%) by more than 10%. Mid cap REITs (+16.80%) continue to underperform, lagging further and further behind their peers as the year has gone on.

Source: Graph by Simon Bowler of 2nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

14 out of 20 Property Types Yielded Positive Total Returns in July

70% of REIT property types averaged a positive total return in July, with an 18.87% total return spread between the best and worst performing property types. Single Family Housing (+5.51%) and Shopping Centers (+4.76%) had the best average returns. Single Family Housing’s strong return was driven primarily by Reven Housing REIT (RVEN) with a 22.25% return. Reven has consistently had higher price volatility than nearly every other REIT throughout 2019. Corrections (-13.36%) had the worst average performance again in July, continuing to be dragged down by a growing number of big banks that have publicly stated they will no longer provide financing to private prisons after facing relentless pressure from political activists to stop lending to companies that operate private prisons or provide services to U.S. Immigration and Customs Enforcement. Sell-side analysts have also now caved to the political and media pressure and ceased covering the private prison REITs.

Source: Table by Simon Bowler of 2nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

All REIT property types except for Malls and Corrections remain in the black thus far in 2019. Industrial (+40.99%) and Land (39.04%) remain the best performing property types year to date. 90% of REIT property types average double-digit positive returns this year. Despite a positive return in July, Mall REITs (-8.34%), are badly underperforming the REIT sector as a whole (+20.8%), due largely to a disproportionately large number of retailer bankruptcies, most of which occurred in the first half of 2019.

Although their approaches vary somewhat, every mall REIT is aggressively redeveloping their properties and working to replace the vacant or soon to be vacant big boxes as well as some in-line spaces. Many malls are being converted into town centers and creative mixed-use replacements are currently being constructed. Some examples are hotels, multifamily, co-working spaces and even casinos. Although malls are currently out of favor among investors and to a lesser extent with shoppers, there is great potential for these newly transformed malls to generate significant new foot traffic. For example, the Fashion District, a joint venture by Macerich (MAC) and Pennsylvania REIT (PEI), is set to open in downtown Philadelphia on September 19th. This mall will feature the first full service mainstream movie theater in downtown Philly since the Boyd theater closed in 2002, providing the potential to draw significant foot traffic.

Source: Table by Simon Bowler of 2nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

The REIT sector as a whole saw the average P/FFO (2019) increase modestly (from 15.3x up to 15.6x) during July. Seven months into 2019, REITs now trade 2.5 turns above the 13.1x average FFO multiple at which they began the year. During July, the average FFO multiples rose for 65% of property types, fell for 20% and held steady for 15%. Single Family Housing (25.1x) continues to trade at the highest average multiple. Corrections (7.6x) suffered significant multiple contraction for the 2nd month in a row and now trades at an even lower average multiple than Mall REITs.

Source: Table by Simon Bowler of 2nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

Performance of Individual Securities

Condor Hospitality Trust (CDOR) had the highest total return of any equity REIT in July, primarily due to the announcement on July 22nd that it would be acquired by Toronto-based NexPoint Hospitality Trust. The acquisition price of $11.10/share was a 34% premium to Condor’s closing share price of $8.27 on the prior trading day. This strong July return brings Condor’s year-to-date total return up to an impressive 67.41%.

CoreCivic (CXW), one of two private prison REITs, was the worst performing REIT in July with a decline of -15.99%. CXW and GEO Group (GEO) (-10.73%) have seen their share prices decline significantly in each of the last 2 months as politicians and the media have attacked both REITs with increasingly incendiary rhetoric. In recent months, the attacks by activists have turned violent as a man armed with a rifle hurled Molotov cocktails at the building, vehicles and propane tank of a GEO Group ICE facility in Tacoma on July 13th. One month later on August 13th, shots were fired into the offices of ICE and GEO Group in San Antonio as well. The rapidly escalating attacks on the private prison REITs overshadowed the very strong 2Q earnings from both REITs. GEO Group raised AFFO/share guidance by $0.04 at the midpoint and CXW raised FFO/share guidance by $0.10 at the midpoint. Both REITs achieved stellar FFO/share growth year over year and expressed optimism for strong growth going forward as well.

69.83% of REITs had a positive return in July, with 90.11% in the black year to date. During the first seven months of last year, the average REIT had only a +1.73% return, whereas this year the average REIT has already seen a total return 12x higher (+20.80%).

For the convenience of reading this table in a larger font, the table above is available as a PDF as well.

Dividend Yield

Dividend yield is an important component of a REIT's total return. The particularly high dividend yields of the REIT sector are, for many investors, the primary reason for investment in this sector. As many REITs are currently trading at share prices well below their NAV, yields are currently quite high for many REITs within the sector. Although a particularly high yield for a REIT may sometimes reflect a disproportionately high risk, there exist opportunities in some cases to capitalize on dividend yields that are sufficiently attractive to justify the underlying risks of the investment. I have included below a table ranking equity REITs from highest dividend yield (as of 7/31/2019) to lowest dividend yield.

For the convenience of reading this table in a larger font, the table above is available as a PDF as well.

Although a REIT’s decision regarding whether to pay a quarterly dividend or a monthly dividend does not reflect on the quality of the company’s fundamentals or operations, a monthly dividend allows for a smoother cash flow to the investor. Below is a list of equity REITs that pay monthly dividends ranked from highest yield to lowest yield.

Source: Table by Simon Bowler of 2nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

Valuation

NAV Data as of July 31st, 2019.

The REIT sector median discount to net asset value narrowed in July from 6.6% to 6.4%.

Self Storage and Health Care both saw their NAV premiums increase to 18.8% and now trade at the greatest median NAV premiums of all REIT property types. Other Retail (this is retail that is neither regional malls nor shopping centers. For example: free-standing Triple Net Retail) saw its median NAV premium decline for the 3rd straight month, falling from 14.3% to 10%. Innovative Industrial Properties’ (IIPR) share price fell back sharply in July (from $123.56 to $105.67), but still trades at the largest NAV premium (98.9%) of any REIT.

Mall REITs continue to take a beating in the market and remain at the largest median discount (-40.8%) to consensus NAV. Ashford Hospitality Trust (AHT), managed by notoriously self-serving Monty Bennett’s Ashford Inc. (AINC), has seen the share price continue to freefall and has now surpassed Cedar Realty Trust (CDR) as the REIT trading at the largest discount (-54.8%) to consensus NAV. Braemar Hotels & Resorts (BHR), also managed by the aforementioned Ashford Inc., has now fallen to the 6th largest discount as well.

Takeaway

For many months in a row, the large cap REIT premium grew larger and larger, reaching a peak of 64.3% at the end of June. It has finally begun to decline, but still remains exceedingly high. Investors are still paying on average nearly 63% more for each dollar of FFO/share to buy large cap REITs than small cap REITs (21x/12.9x - 1 = 62.8%). It is important to note that these averages are the result of numerous large cap REITs trading at sky-high multiples and many small cap REITs trading at exceedingly low multiples. Within each category there is, however, tremendous variance. Small cap FFO multiples range from 0.75x to 43.25x and large cap multiples range from 9.63x to 32.04x. These ranges may create the impression that maybe pricing isn’t overly skewed toward large caps. However, the following statistic may clarify just how big the difference really is:

The average small cap REIT trades at a multiple of 12.9x FFO, whereas only one large cap REIT trades below a multiple of 13x. Every single other large cap REIT trades at a premium to small cap REITs.

Source: Table by Simon Bowler of 2nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

This massive market cap-based spread presents a potentially very lucrative arbitrage opportunity for investors. By carefully analyzing REIT data and industry trends, active investors have the opportunity to outperform ETFs.

Disclosure: I am/we are long CXW, GEO, MAC, PEI & CDR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: 2nd Market Capital and its affiliated accounts are long CXW, GEO, MAC, PEI and CDR. I am personally long GEO, MAC and PEI. This article is provided for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer. Information contained in this article is impersonal and not tailored to the investment needs of any particular person. It does not constitute a recommendation that any particular security or strategy is suitable for a specific person. Investing in publicly held securities is speculative and involves risk, including the possible loss of principal. The reader must determine whether any investment is suitable and accepts responsibility for their investment decisions. Simon Bowler is an investment advisor representative of 2MCAC, a Wisconsin registered investment advisor. Positive comments made by others should not be construed as an endorsement of the writer's abilities as an investment advisor representative. Commentary may contain forward looking statements which are by definition uncertain. Actual results may differ materially from our forecasts or estimations, and 2MCAC and its affiliates cannot be held liable for the use of and reliance upon the opinions, estimates, forecasts and findings in this article. Although the statements of fact and data in this report have been obtained from sources believed to be reliable, 2MCAC does not guarantee their accuracy and assumes no liability or responsibility for any omissions/errors.